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My objective in writing this article is to dispell a myth that should have been dispelled a long time ago when it comes to the tax advantages to owning a home. For purposes of my objective, a better title to this article should be “The Tax Advantages to Owing on Your Home” because you only get the tax advantages if you are in debt.
Really quickly, we’ll move through the tax advantages to owning (owing) a home. When you enter into a mortgage, as you probably know, a large portion of your monthly payment will go towards interest. As you pay down the principal, the interest portion of the monthly payment grows ever smaller, while the principal amount of your payment (the portion that goes towards actually paying down your debt) grows ever bigger. This interest is tax deductible if you choose to itemize your tax deductions. This tax advantage can be pretty lucrative for just about everyone – especially when you’ve first entered into the mortgage because you will naturally pay more interest.
However, it is a tax advantage. If you could choose to pay tax or pay taxes with an advantage, you’d choose the latter. That makes perfect sense. But never forget how this tax advantage actually becomes available.
You have to be paying interest.
Even savvy tax advisors will tell people the following: “Oh no, don’t pay your home off early. You’ll lose your tax deduction!” I feel sick to my stomach. Very well educated people tote this as a reason to stay in debt.
Would you like to guess who really pushes the tax advantages to owning (owing) a home? You got it–mortgage brokers, banks, loan officers, etc. They stand to profit from you stringing that mortgage out as long as you possibly can. They’re probably hoping you’ll take out an equity loan as soon as you get a chance too. There’s a conflict of interest if you’re taking advice from your lender when it comes to the tax advantages of owning a home.
The lender will give you, let’s say, a 7% interest rate. At the same moment he’ll tell you that the real rate or effective rate is only 5.6% if you’re in the 20% tax bracket, and 4.9% in the 30% tax bracket (you can get to these numbers with the following formula: interest rate * (1 – tax rate) ).
They never really mention that the tax advantage is only made available because you’re still paying them 5.6% or 4.9% on the loan.
Owning a home is a wonderful, wonderful thing. When I say owning I mean owning. You don’t make house payments. We’ll run two different scearios to drive home this point. Paying your house off early is and always will be better than having a tax deduction for the interest you pay.
We’ll use the following numbers:
|Keep Mortgage||Pay it off*|
*This assumes you make two extra payments per year towards your principal
By making only two extra payments per year you are out of debt 10 years faster and save $48,317.68! Remember, I’m including the tax “advantage” to owning a home in this calculation. Any way you cut the cake it’s still going to come out the same.
Finally, the tax advantage is there to promote home ownership, so I do appreciate it. It certainly does help. It is a nice benefit. But in no way does it outweight being entirely debt free with almost $50,000 saved as a result. Think about it this way–would you give me $1 to save $.25? Of course not. Yet that is exactly what you’re doing when you decide to not pay off your mortgage in favor of a tax advantage you will be giving up. That is a ludicrous idea. The numbers are here and they speak for themselves. Ownership will always be better than borrowing when it comes to funding your lifestyle securely.
Remember, budgeting is not restrictive. You won’t be spending less, you’ll be spending right. You can do this! Today. Right now. What do you have to lose? Except all that debt and stress. (Ok, so kind of a lot.)
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